Flexible cash rental arrangements gaining interest

LITTLE ROCK, Ark. -- At the time of this writing, a quick review of commodity prices reveals that July ’04 wheat futures prices have increased 38 percent over a year ago. Likewise, November ’04 soybean futures prices have increased 49 percent and cash-per-bushel rice prices are a remarkable 106 percent higher than one year ago.

These price changes are certainly emblematic of the fast-paced and volatile market environment that production agriculture faces today. Because of the rapid and wide fluctuations, flexible cash-rent arrangements have become more attractive to both landlords and tenants as a method of sharing price risk.

A flexible cash-rental arrangement can set both a minimum and maximum rental for a given crop. Plus, it doesn’t require annual or regular adjustment. Price changes are accounted for in the current year rather than deferring the adjustments into the year ahead — when the rental change may become obsolete.

The first step in developing a flexible cash rent is to establish a “base rent.” The going cash rental rate for your area can be used as a guide, but it should only be used as a starting place. Rental rates often need to be adjusted for the productivity of the farm.

Also, both tenant and landlord need to develop and communicate their desired returns. Negotiation provides a means of arriving at a rental rate that is acceptable to both parties and is an opportunity for them to understand each other’s point of view.

The second step is to determine a “base price.” This can be derived from historical records — perhaps a five-year average. State statistical services are a good resource for historic commodity prices. Links to all state statistical offices can be found at www.nass.usda.gov. Most commodity exchange Web sites provide historic price information as well.

The “current price” to be used in such calculations must be agreed upon by both the tenant and landlord in advance. This price may be the average cash grain price at the local elevator for a specific time period; a Board of Trade closing price for a particular date; or any other method agreeable to all parties.

Adjustments can then be made for price variation by simple calculation:

Adjustment for price variation:

Adjusted current rent = (base rent) x Current price/Base price

Assume a particular farm has an average soybean yield of 40 bushels per acre. Both parties initially agree on a base rent of $60 per acre and a base price of $6.00 per bushel.

If their flexible cash lease calls for adjustment for price variation only, and if the current price is determined to be $7.50, the calculation would reflect a current rent of $75 per acre.

$75 = $60 x $7.50/$6.00

To provide some price and income protection for all parties, the tenant and landlord may want to agree to a predetermined minimum and maximum rent. For example, a soybean farm may have a base rent of $60 per acre, but also have a minimum rent of $50 per acre and a maximum of $80. As mentioned earlier, rents have to be negotiated by both parties.

The flexible cash-rent arrangement does have the potential of arriving at a more equitable agreement for both parties during periods of rapidly changing crop prices. However, there are both advantages and disadvantages to be considered.

Advantages and disadvantages of flexible cash renting:

Advantages

• Flexible cash rent enables the landlord to share in the additional income that results from unexpected commodity price increases.

• For the tenant, risk is reduced. Cash-rent expense is lower if crop prices are less than normal.

Disadvantages

• For the landlord, flexible cash rent can reduce income stability.

• For the tenant, profits that may be realized from unexpected price increases are reduced.

Regardless of the cash rent arrangement agreed on by the tenant and landlord, it should be put in writing to reduce the likelihood of future misunderstandings. Consult a knowledgeable agricultural attorney for guidance on renewing a lease, canceling a lease, timing of rent payments, and compensation for unused investments, such as fall tillage or applied fertilizer in the event a lease agreement is canceled.

Scott Stiles, James Marshall, Rob Hogan and Kelly Bryant are University of Arkansas Extension economists. Comments or questions? Call 870-460-1091 or bryantk@uamont.edu.